Friday, February 27, 2009

Regulate or de-regulate?

Our current economic crisis is an example of what has occurred many times in past, given slavish adherence to deregulation dogma. In an almost religious quest for deregulation, we've suffered a repeat of the kind of impact we saw with the savings and loan crisis, derivatives debacle, junk bonds, etc. (yet with each occurrence, we've seen an increased magnitude of impact). In fact, the over-leverage by financial institutions in their investment in mortgages is reminiscent of the over-leverage by investors in the stock market of 1929.

Deregulation shouldn't be a religious quest by believers in a free market. The New York Stock Exchange - a global exemplar of a free market - depends on a high degree of regulation to ensure its reliable, efficient operation.

Now, with the problems caused by decades of over-deregulation, we can expect government regulators to step in and close the barn door after they've let the horses out. I'm not arguing that we don't need additional regulation. Re-regulation is needed to attempt to prevent similar bad things from recurring in the future. Such regulation may be appropriate, but trying to preventing unwanted outcomes is not the only approach that should be considered.

My first job was in management consulting within a public accounting firm. As a young associate, I was taught lessons in basic controls. Such controls are of two types: prevention controls and detection controls. Prevention controls keep bad things from happening (for example, preventing employees from stealing money from their company). Detection controls don't directly keep bad things from happening, but detect bad things after they happen (finding out that an employee stole money from the company). Well, what good is that? In the theft example, if the company had something of the employee's, it could claim restitution of the stolen funds - from the employee's next paycheck or pension funds.

Given all the focus on and resistance to regulation, it appears that few lawmakers, government regulators, or bureaucrats know of these 2 types of controls. They focus solely on prevention controls. What's wrong with that? Prevention controls are very expensive. And they're often viewed to be oppressive. In fact, they are sometimes inappropriate, given the level of risk and the potential of detecting the problem and possibility of gaining restitution.

So let's hope this time, policy makers, regulators, and bureaucrats consider such detection controls instead of relying solely on prevention controls. If they don't, they'll inevitably over-regulate, putting us into yet another round of ping-ponging to over-regulation begetting frustration then under-regulation again. And each time, it will cost us each more.

4 comments:

Again, this is a good example that going to the extreme is a bed idea. Greenspan was a firm believer that regulation was not necessary because the banks were self-regulated out of their self-interests. He now realized that he was wrong, but it was too late. The damage was done.

Prevention or Detection controls? We need both. Everyone walks their dogs every day, but no one wants to pick up the dog shit in our community. The Home Owners Association has tried almost everything possible to prevent this kind of behavior, but without success. My suggestion to the HOA was to install surveillance cameras and impose a heavy fine on the violators.

Imposing heavy fines is only part of an answer (I did that as tax commissioner, getting 7 new felony crimes put into law to help stem tax evasion). The other necessary part, though, is to detect the bad activity (we developed new computer systems and staff organizations to track down evaders who we would bring to justice).

In addition to tough monetary or incarceration penalties, though, there are less draconian approaches. For example, make the bad behavior less socially acceptable. For dog owners who don't scoop their pet's poop, publicizing their names might help (just as communities have done with those who patronize prostitutes).

Another alternative is to have the offenders more directly suffer the consequences of their deeds. Some wealthy dog owners might consider the cost of a fine to be a small price to pay every now and then, rather than to scoop the poop every day. I recall the old school prank of scooping up poop, putting it in a paper bag, leaving it at the doorway of the offender, and lighting the bag. When the offender stamped out the burning bag .... Ah, poetic justice! Of course, I'd never advocate such a prank, but just leaving the bag on the offender's doorstep would make a memorable point.